World Bank/ Agro AsemexWorld Bank/ Agro Asemex

Comprehensive Management of Comprehensive Management of Agricultural Climate RiskAgricultural Climate Risk

Rodney Lester, Cuidad de QueretaroRodney Lester, Cuidad de Queretaro

Mexico, October 9, 2008Mexico, October 9, 2008

Skippy for dinnerWho We Are: How to make Australians eat kangaroo.

The climate change debate can The climate change debate can take some bizarre turnstake some bizarre turns

Source: Garnaut Report, Ch 22 – recommending that 240 million kangaroos replace 7 million beef cattle and 36 million sheep by 2020 to reduce methane emissions

A: The current big picture – A: The current big picture – balanced thinking versus balanced thinking versus

dooms-dayersdooms-dayers

My takeMy take1::

Climate change is occurring’Climate change is occurring’

and there is a human effect, butand there is a human effect, but

there is huge uncertainty in modelsthere is huge uncertainty in models

Kyoto, Stern etc are poor trade offs for current and next Kyoto, Stern etc are poor trade offs for current and next few generations in an economic sense and are not few generations in an economic sense and are not politically acceptablepolitically acceptable

The sensible debate is now about priorities and trade The sensible debate is now about priorities and trade offs,offs,

and a key issue is the real shadow price of and a key issue is the real shadow price of atmospheric carbon ($2 to >$100)atmospheric carbon ($2 to >$100)

There is a battle going on between an ‘end of the world’ group and economic rationalists

1. Not necessarily WB policy

Copenhagen Consensus PrioritiesCopenhagen Consensus Priorities

www.copenhagenconsensus.com/Default.aspx?ID=788

B: The current ag. risk picture – not much B: The current ag. risk picture – not much regional change in the short/ medium term regional change in the short/ medium term (except Africa?), and not much aggregate (except Africa?), and not much aggregate

change long term but change long term but ……..……..

Impact of CC is highly complex – Macaulay Impact of CC is highly complex – Macaulay Institute/ ISCIInstitute/ ISCI

Two marginal sites – Italy, Scotland – 2030 and 2090Two marginal sites – Italy, Scotland – 2030 and 2090Demonstrates highly complex nature of interactions – e.g Demonstrates highly complex nature of interactions – e.g earlier cropping of grains but reduced biomass because earlier cropping of grains but reduced biomass because of shorter period to maturityof shorter period to maturityMore heterogeneous rainfall distributionMore heterogeneous rainfall distributionIncreased productivity for heat loving crops (tomatoes Increased productivity for heat loving crops (tomatoes etc) but increased water demandetc) but increased water demandLikely need to change rotation systems – and some Likely need to change rotation systems – and some crops may become non viablecrops may become non viableIncreased yield variabilityIncreased yield variability

www.macaulay.ac.uk/LADS/papers/British_Council_report.pdf

IPCC 4 sees mixed CC medium term impacts in Latin America

Source: IPCC 4, Synthesis Report

ODI also sees increased volatilityODI also sees increased volatility

Not much change in average yields in the Not much change in average yields in the short term (next 20 years) except Africa, short term (next 20 years) except Africa, butbut

frequency and severity of extreme events is likely frequency and severity of extreme events is likely to increase – mainly in areas already susceptibleto increase – mainly in areas already susceptibleMany tropical crops are already near threshold Many tropical crops are already near threshold temperaturestemperaturesExtreme hydro- meteorological events will become Extreme hydro- meteorological events will become more frequent for most land areas over the longer more frequent for most land areas over the longer termterm

Source: ODI. A rough guide to climate change and agriculture, March 2007

But it is clear -the developing world is worst But it is clear -the developing world is worst affected in the long runaffected in the long run

Summary Estimates for Impact of Global Warming onWorld Agricultural Output Potential by 2080s (percent)

Without carbon With carbon fertilization fertilization

World -16 -3Rich countries -6 8Developing countries -21 -9Median -26 -15Africa -28 -17Asia -19 -7Middle East- North Africa -21 -9Latin America -24 -13

Mexico -35 -26

Based on Cline, William, Global Warming and Agriculture: Impact Estimates byCountry, Table 7.1.

However there is great uncertainty in However there is great uncertainty in projectionsprojections

Results, selected countries(percent change in agricultural productivity) Ricardian Crop Model Weighted Avg w/oCF w/CFArgentina -4 -18.1 -11.1 2.2Brazil -5.1 -28.7 -16.9 -4.4US 4.7 -16.5 -5.9 8.0SW plains -11.1 -59.0 -35.1 -25.0India -49.2 -27.0 -38.1 -28.8China 3.8 -12.6 -7.2 6.8S. Central -18.8 -12.6 -14.6 -1.8

Based on Cline, William, Global Warming and Agriculture: Impact Estimates byCountry, Table 7.1.

Including priceIncluding price

Ref: FAO. Adaptation to Climate Change in Agriculture, Forestry and Fisheries, 2007

And models are incompleteAnd models are incomplete

Factors not allowed for:Factors not allowed for:

Positive: Technology improvement (e.g. flood tolerant Positive: Technology improvement (e.g. flood tolerant rice, drought tolerant wheat and maize) rice, drought tolerant wheat and maize)

Changed income mixesChanged income mixes

Negative: Increased weather volatilityNegative: Increased weather volatility Insect infestationInsect infestation Loss of water table and glacial water (short Loss of water table and glacial water (short

term increase for the latter) term increase for the latter) Loss of species diversityLoss of species diversity

?: ?: Feedback loops (e.g. from land use change) Feedback loops (e.g. from land use change) Scale effects – climate model v. farm systemsScale effects – climate model v. farm systems

C: A comprehensive value chain C: A comprehensive value chain approach is requiredapproach is required

Value chain management can reduce Value chain management can reduce riskrisk

Case Study of Maize Procurement Case Study of Maize Procurement Centers – AP/ IndiaCenters – AP/ India

Federated Institutions with own savings and credit productsFederated Institutions with own savings and credit products

Procurement CentersProcurement Centers Physical infrastructure (i.e., small rented or own building, weighing Physical infrastructure (i.e., small rented or own building, weighing

instruments, moisture meters, and sieving equipment)instruments, moisture meters, and sieving equipment)

Trading Platform (to be networked with Virtual Private Network).Trading Platform (to be networked with Virtual Private Network).

Developing good quality network of service providers with the Developing good quality network of service providers with the following skillsfollowing skills: :

• Market Based InformationMarket Based Information: Micro planning for procurement & Market : Micro planning for procurement & Market Research DataResearch Data

• Quality Control:Quality Control: Moisture control, grading Moisture control, grading• Financial Management: Financial Management: Accounting & Book keeping Accounting & Book keeping• LogisticsLogistics• Enterprise ManagementEnterprise Management• Labor Management & Conflict ResolutionLabor Management & Conflict Resolution

Procurement Centers in AP have raised farmer incomes

1610 Procurement centers

81 Commodities

$100 Millions in turnover

Over 200,000 Paraprofessionals: Barefoot Botanists, Book keepers, Quality Controllers

Partners include: (i) AP Markfed (Largest Cooperative in Agricultural Products in the State)(ii) ITC Ltd (Agribusiness Multinational)(iii) Olam International (Largest Exporter of Cashews in the World)(i) Agrotech Foods Ltd. (Multinational with dominant share in the refined oil

segment)

Products include: Turmeric, Lac, Maize, Neem, Red Gram, Sunflower Seeds, Cashew, Groundnut, Organic Cotton

Source: Rao.K.P et al. South Asia Rural Livelihoods Series 1, Notes 2 and 4, World Bank

Procurement Center Franchise ModelProcurement Center Franchise Model

For small and marginal farmers:For small and marginal farmers:

Enhanced Price (+10%)Enhanced Price (+10%) Weighing Benefits (+5-10%)Weighing Benefits (+5-10%) Saving on Driage Loss (50% less than Saving on Driage Loss (50% less than

middle men)middle men) Saving on transportation (+ 15 – 20%)Saving on transportation (+ 15 – 20%) Elimination of price uncertaintyElimination of price uncertainty Saving on one day wage laborSaving on one day wage labor Cash PaymentCash Payment

Source: Rao.K.P et al. South Asia Rural Livelihoods Series 1, Notes 2 and 4, World Bank

Savings and credit have a role in inter-Savings and credit have a role in inter-temporal consumption smoothing – but not temporal consumption smoothing – but not for relatively infrequent severe systemic for relatively infrequent severe systemic

eventsevents

Informal credit – breaks down under Informal credit – breaks down under systemic risk and societal changesystemic risk and societal change

Microfinance – if available – but not useful Microfinance – if available – but not useful in extreme situationsin extreme situations

Savings – if safe mechanisms are Savings – if safe mechanisms are available – but again not able to deal with available – but again not able to deal with extreme situationsextreme situations

D: Insurance plays a key role for D: Insurance plays a key role for production risk – but it’s a case of production risk – but it’s a case of

horses for courseshorses for courses

Key Assumption for what followsKey Assumption for what follows

Price is set by international markets, or Price is set by international markets, or otherwise independent of domestic yieldotherwise independent of domestic yield

Limited direct public interventions in markets (e.g. Limited direct public interventions in markets (e.g. central purchasing boards).central purchasing boards).Reasonably efficient value chain – storage, Reasonably efficient value chain – storage, transport, pricing methods etctransport, pricing methods etcLimited misaligned incentives (e,g, corn ethanol Limited misaligned incentives (e,g, corn ethanol subsidies) subsidies) No systemic global weather correlationsNo systemic global weather correlations

Insurance seen as an important mechanism by Rio, Kyoto and IPCC

4th AR

Source: IPCC 4, Synthesis Report

Role of Insurance –Hazell et al – 1986 Role of Insurance –Hazell et al – 1986 seminal bookseminal book

Increase agricultural efficiency by reducing Increase agricultural efficiency by reducing ex ante riskex ante risk

Smooth income ex postSmooth income ex post

Mechanism for social transfers – political Mechanism for social transfers – political rather than effective approach – direct rather than effective approach – direct transfers work better.transfers work better.

Does it makes sense – rational economic Does it makes sense – rational economic modelmodel

Overall benefit – Overall benefit –

OADOAD

Ultimate benefit to Ultimate benefit to farmer – farmer – PP11DO – PDO – P00AOAO

– Determinants Determinants Elasticity of demandElasticity of demand

Net price of insuranceNet price of insurance

Source; Hazell, P et, al. Crop Insurance for Agricultural Development, John Hopkins, 1986, Ch 7 (Siamwalla

and Valdes)

It did not work with traditional indemnity It did not work with traditional indemnity insuranceinsurance

Subsidy necessary for all except hail, fire and Subsidy necessary for all except hail, fire and single crops (typically >50% total cost)single crops (typically >50% total cost)

Moral hazard – farmer harvests insurance rather Moral hazard – farmer harvests insurance rather than cropsthan crops

Information asymmetry – farmer knows more Information asymmetry – farmer knows more about risk than insurerabout risk than insurer

Administration – crop inspection, loss Administration – crop inspection, loss assessment and opportunity cost of time to assessment and opportunity cost of time to payment of claimpayment of claim

Political capturePolitical capture

And pricing (expected loss plus And pricing (expected loss plus expense loading plus cost of capital) expense loading plus cost of capital)

can be high for other reasonscan be high for other reasons

Trigger is hit too frequently – inefficient use of Trigger is hit too frequently – inefficient use of insurance – credit and savings, (direct donor insurance – credit and savings, (direct donor support for sovereigns) may be better support for sovereigns) may be better instrumentsinstruments

High losses and uncertainty for infrequent High losses and uncertainty for infrequent events pushes up capital charge and cost of events pushes up capital charge and cost of capitalcapital

The agriculture involved is non viable – a policy The agriculture involved is non viable – a policy issue not a market issueissue not a market issue

In addition willingness to pay shows In addition willingness to pay shows complex patternscomplex patterns

Morocco (cereal) – willing to pay 12% to Morocco (cereal) – willing to pay 12% to 20% above expected loss for contract – 20% above expected loss for contract – but only for lower triggers in low variability but only for lower triggers in low variability areas – areas – MCarthy, N. IFPRI using WB study as inputMCarthy, N. IFPRI using WB study as input

Vietnam (litchi) – farmers overestimate Vietnam (litchi) – farmers overestimate area yields, wealthier farmers more likely area yields, wealthier farmers more likely to participate – education important – to participate – education important – Vandeveer, M. USDA, published in Agricultural Economics, 2001Vandeveer, M. USDA, published in Agricultural Economics, 2001

However, subsidies are hard to justify in a However, subsidies are hard to justify in a welfare economics frameworkwelfare economics framework

Economically inefficient per indifference Economically inefficient per indifference curvescurves

May be justified:May be justified:To build institutions and infrastructure if To build institutions and infrastructure if free rider problem existsfree rider problem existsDuring initial learning curves of suppliers During initial learning curves of suppliers and consumersand consumersTo support new technology – but To support new technology – but questionablequestionable

An idealAn ideal

Cost/ price nearer to expected lossCost/ price nearer to expected loss

Simple objective claims triggers linked to Simple objective claims triggers linked to actual loss - reduced or no in field crop actual loss - reduced or no in field crop and loss assessmentsand loss assessments

Simple pay out formulaeSimple pay out formulae

Rapid payout of claimsRapid payout of claims

Correct risk level signalingCorrect risk level signaling

No direct long term subsidiesNo direct long term subsidies

Initial WB studies (early 2000s) : rural bank Initial WB studies (early 2000s) : rural bank exposures to drought, emerging degree day market exposures to drought, emerging degree day market in the US, seed funds from WB President and FSE VPin the US, seed funds from WB President and FSE VP

Mexico: For about 40% of the planted area, rainfall contracts could Mexico: For about 40% of the planted area, rainfall contracts could reduce relative yield risk between 9% and 29%. More specifically, reduce relative yield risk between 9% and 29%. More specifically, in Durango the risk reduction in yields is 23%, in Jalisco 28.6%, in in Durango the risk reduction in yields is 23%, in Jalisco 28.6%, in Tamaulipas 9% and in Zacatecas 29%. Tamaulipas 9% and in Zacatecas 29%.

Morocco: Morocco:

Two possible approaches the Two possible approaches the WB now supportsWB now supports

Parametric Parametric – based on – based on objective weather or objective weather or related metricrelated metric

Low cost, objective, butLow cost, objective, but–Basis riskBasis risk–Need tamper proof Need tamper proof measurement measurement infrastructureinfrastructure

IndexIndex – based on area – based on area yields (e.g. cereals) or yields (e.g. cereals) or animal census data.animal census data.

Less basis risk, Less basis risk,

butbut–Still need to measure Still need to measure area losses (sampling/ area losses (sampling/ census)census)–Claims payment can be Claims payment can be delayeddelayed

And the response depends on the client and And the response depends on the client and the hazardthe hazard

Nature of Nature of consumerconsumer

Type of hazardType of hazard Suitable insurance Suitable insurance instrumentsinstruments

Government – fiscal Government – fiscal managementmanagement

Cities – EQ, Cyclone etcCities – EQ, Cyclone etc

Rural – Drought, floodRural – Drought, flood

Cat bonds, parametric Cat bonds, parametric insurance (+DDO)insurance (+DDO)

Parametric insurance Parametric insurance (little basis risk)(little basis risk)

Credit institutionCredit institution Drought, flood, freeze etcDrought, flood, freeze etc Parametric insurance at Parametric insurance at aggregate level (reduced aggregate level (reduced basis risk)basis risk)

Individual farmer, Individual farmer, supplier, intermediarysupplier, intermediary

As aboveAs above Index insurance if basis Index insurance if basis risk too high. Multi risk too high. Multi trigger parametric trigger parametric insurance if correlations insurance if correlations are high enough.are high enough.

Example of parametric payoff scheduleExample of parametric payoff schedule

Reference: Skees, J. The Potential of Weather Insurance for Spurring a Green Revolution in Africa

Other issuesOther issues

Links to creditLinks to creditAppropriate insurance infrastructure – involve Appropriate insurance infrastructure – involve the local industry or separate fund or the local industry or separate fund or combination (PPP)?combination (PPP)?Appropriate legal infrastructure – status of Appropriate legal infrastructure – status of parametric covers – insurance or derivatives?parametric covers – insurance or derivatives?Education of farmers/ herders – quality of Education of farmers/ herders – quality of outreach services?outreach services?Payment in non cash/ non bank account Payment in non cash/ non bank account societies?societies?Role of government targets/ suasion (India and Role of government targets/ suasion (India and South Africa)South Africa)

Some additional questions will need to be Some additional questions will need to be asked in the longer term CC scenarioasked in the longer term CC scenario

How valid will past experience be for How valid will past experience be for pricing, benefit and trigger design?pricing, benefit and trigger design?

Can these concerns be overcome by Can these concerns be overcome by actuarial techniques and physical actuarial techniques and physical modeling – e.g credibility methods, modeling – e.g credibility methods, agronomic models etcagronomic models etc

E: A taxonomy of initiativesE: A taxonomy of initiatives

CaseCase Nature of clientNature of client Mechanism: Mechanism: Separate pool + Separate pool + R/I/ market R/I/ market insured/IFI insured/IFI instrument/ instrument/ combinationcombination

Instruments Instruments employedemployed

Mongolia – freeze Mongolia – freeze and droughtand drought

HerderHerder MarketMarket Index Insurance [+ Index Insurance [+ DDO]DDO]

India – AICI - India – AICI - revenuerevenue

Cash farmerCash farmer MarketMarket Index InsuranceIndex Insurance

India – AICA - India – AICA - rainfallrainfall

Cash farmerCash farmer MarketMarket Parametric Parametric InsuranceInsurance

Caribbean Islands Caribbean Islands – hurricane, – hurricane, volcano, EQvolcano, EQ

SovereignSovereign Separate poolSeparate pool Parametric R/I, Cat Parametric R/I, Cat Swap (IFI)Swap (IFI)

Ethiopia – drought Ethiopia – drought [food security][food security]

SovereignSovereign MarketMarket Parametric Parametric InsuranceInsurance

Malawi - rainfallMalawi - rainfall SovereignSovereign IFIIFI WB derivativeWB derivative

Some lessons learned over the last decadeSome lessons learned over the last decade

Each situation is different – there are no silver bullets – Each situation is different – there are no silver bullets – do a do a decent diagnosticdecent diagnostic first first

Integrate into the Integrate into the full value chainfull value chain of interventions of interventions

InfrastructureInfrastructure development will often be required in development will often be required in advanceadvance

Educating the consumer will take time – but long term Educating the consumer will take time – but long term subsidies are usually welfare reducingsubsidies are usually welfare reducing

The design will usually need The design will usually need tweaking with experiencetweaking with experience – – these projects often require above average levels of these projects often require above average levels of supervision and can cover many years.supervision and can cover many years.

The Donors are now engagedThe Donors are now engaged

EC - €25 million – IFC administered TF for EC - €25 million – IFC administered TF for ACP countriesACP countries

Gates – Initial $1 million then $25 million - Gates – Initial $1 million then $25 million - WFPWFP